Here is one of the first myths that the gurus will teach you. They will say the first thing you need to do is identify an “emerging market”. Look at the cycles and where the market is in its cycle and then buy at the right time. You won’t go wrong.
Here’s what they don’t tell you. If you buy a lousy property in the best market, guess what, it’s still a lousy property. As we say, you can’t put lipstick on a pig.
So before you even think about looking at all the websites and broker sources for any properties for sale, save yourself a lot of time and get to know yourself a little better. Here’s what I mean.
Who are you and why are you here?
Picture your life one year from now, three years, five years. Where are you? What are you doing? How much property do you own? How hard do you plan on working every day? Are you a hands-on owner or do you have another occupation and owning property is your retirement nest egg?
It is imperative to understand what your objectives are in real estate just like you would do with any other type of business. Are you an entrepreneur, manager, technician?
When you answer these questions honestly, then you will know what types of properties you should be looking at. Once that is determined, then you can change the focus and begin looking at particular markets.
I have owned all types of properties – A, B and C quality assets. I can assure you, each one of them comes with their own unique set of issues and problems. My A-class property has had three straight months of 100% occupancy and 100% collections. I have incurred no unbudgeted capital expenditures for the last twelve months. As I tell my wife, we need to own more properties like this one; the kind that you forget you even know you own.
The C-class asset was an entirely different story. As I know tell everyone, from my own personal experience, life is too short to own C-class property. It may be right for some investors, but I have learned that it is not the type of property that I want to be involved with.
The repositioning fallacy
One of the biggest fallacies that I hear many new investors talk about is how much money they are going to make by buying a C-class property in a B-class area and then reposition the property and cash out. Or it could be a B-class in an A-area. Regardless, they never understand what repositioning really means because the most important part of repositioning is never explained properly to them.
Just like with fixing and flipping single family homes, any problem can be fixed with money. You can take a C-class property and drop $6,000 per unit in rehab expenses and make it absolutely gorgeous with granite countertops and hardwood floors but that does not make it a B-class property. Remember what brings value to a multi-value business; the contracts.
The only way to get more valuable contracts is to get higher-paying customers/residents. The fact that a unit has been completely rehabbed and is absolutely beautiful does not mean that a new tenant base is set to move in. Repositioning an asset has two components. First, you must turn the units so that a new class of residents will want to move in and then you have to reposition the tenant base so that you begin receiving the larger valued contracts. The first part is easy. If you have the rehab money, you can have a parade of contractors lining up to rehab your property.
But the second part of repositioning is the hardest part and the one that they never tell you about. Repositioning will fail if you rehab every unit and then re-rent to the exact same clientele that you had living there before. Here’s the success formula for repositioning. For repositioning to succeed, you must purchase a property that, once rehabbed, will be the type of place that a higher level of clientele will want to move into. It’s that simple but believe me, that task is not all that simple.
When you hear yourself saying the words, or hearing the words, “it’s a C-property in a B area”, stop for a moment and think like a B-class resident. Let’s say you are a newlywed couple looking for your first apartment. You have entry-level jobs and you are looking to save money to buy a starter home. Or you just graduated from nursing school and you and your college roommate are looking for a place to live. These are your B-class residents. You know these people. You may have been one yourself. Your children may be in this position right now. What you need to do now is to think like them.
When the broker takes you to look at the property and tells you that this is a great repositioning opportunity; think like a newlywed, think like a new nurse. Would you want to walk down the street late at night with your new puppy or is the neighborhood not the kind of place you would want to be found dead in? Is it the type of location that you would want to have the new in-laws over for Sunday dinner or would you be afraid they would have to step over police tape from the night before to enjoy your yams?
You can change the property. That is within your control. You cannot change the neighborhood. Leave that to ACORN (and we know how successful they have been).
Once I purchased a property that the broker told me was on the edge of a neighborhood that was very desirable. Let’s say for the sake of this discussion, the area within this city was called Eggtown. This property was on the line of Eggtown and North Eggtown. North Eggtown was very desirable. It was going through a period of re-gentrification and all the young people were moving there. The property that I was looking at was located in Eggtown but one street away from North Eggtown.
The broker described this property as being in North Eggtown when he was trying to sell it to me. The residents were less disingenuous. They said they lived in Eggtown. Where do you think the newlywed and the nursing school graduates thought the property was located? They saw the property as being solidly located in Eggtown and were not interested in the refinished hardwood floors and new bathrooms that I had put in all the units. They would not want to tell their other roommates or their new in-laws that they have achieved such great success in their young lives and now live in Eggtown. It wasn’t happening. The repositioning was a bust.
What’s the right property for you?
Allow me to describe for you the lifestyles that I have lived based upon the type of property that I have owned. Once you get a flavor for what each property entails, you will have a better understanding of which type of asset you should be focusing on.
Class A – Life is simple when you own Class A property. My A property was built in the late 1990s, is beautifully landscaped, separately metered utilities and is perfect for a potential condo conversion if the world ever sees those again. The level of capital improvements that takes place on that property is very low. I think the biggest unexpected expense I get is a broken water heater.
More importantly, though, is the quality of residents that I have living there. The police are never called for any crime issues and the last time they were called was because a resident had a heart attack. For a three month period of time this year, this property had 100% occupancy and 100% collections. For those of you experienced in multi-family ownership reading this, you can close your mouths now. It is true. Evictions happen but very infrequently.
If you are looking to get into multi-family investing as a sideline to your day job and you would like to increase your chances of being successful, then only look at buying A-class property. It is more expensive, the returns are lower, and the up-front costs could be higher, but your lifestyle will not change and you will easily start looking for another property just like it.
Class B – This is where the best deals can be found for new investors. But make sure you know that the property you are buying is truly a B-class property and not a C-class in sheep’s clothing. (As we get into the discussion of analyzing the income and expense statement, you will see that there are indicators in the financials that will help you determine whether the property truly is a C or a B class asset).
My B property is a nice property. It is a place that I would not mind living in if I needed a place to stay. The residents are nice people, the majority of them keep their residences neat and they enjoy staying there. There is some crime on the property but it is usually isolated to problems within the household.
The issues that I have with the property primarily stem from its age. It was built in the late seventies through the mid eighties. As a result of its age, things always need to be fixed. Twice in the last two years I have had to have my plumber come in and replace the water pipes from the street. (I love how it is never the city’s responsibility. Always mine). This just means that when you are calculating your budget, you need to make sure that you reserve enough cash to cover these types of expenses. B properties burn through cash much faster than A properties. Be prepared. Regardless, if the property is purchased at the right price, B class property can be a great investment.
Class C- What follows is my own personal opinion learned from personal experience. I will never purchase a C-class property again. It may be right for some investors but it does not fit my investment strategy. As I now say, life is too short to own C-class property.
C-class property is a tough property to own both from a physical plant basis as well as a clientele basis. They are the oldest property and therefore have the most upkeep. There is always something going wrong with it. If you get into a C-class deal without having a large bucket of money to start rehabbing units and keeping the lights on while you do that, then you have just created a monster. That is the easiest recipe for disaster.
In addition, the mindset of the C-class property resident, if you are like most people, is like nothing you have ever known or been able to understand. You have to have a very strong back if you are looking to get into this side of the business. The only good thing that I can say about my experience is that I learned it early in my career at a time when I could recover financially from the disaster that it became.
Let me stress this again. This is my personal experience. There are many investors that make a great living investing in C-class property. I just learned very early on what my limitations were. If I had a contractor’s mindset, I would be able to walk into these types of properties and see dollar signs all day long. Unfortunately, I don’t. I see the financials of a property and base my decisions on that.
Posted on December 28, 2010 by admin
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